Division 7a is a tax integrity provision that was introduced to prevent private companies from providing financial benefits to their shareholders (or associates) tax-free. In this article, we explain who it applies to and how to avoid falling foul of it.
What is Division 7a?
In simple terms, Division 7a ensures that private company shareholders and their associates pay the appropriate amount of tax on financial benefits received from the company. This extends to payments, use of company assets, loans and even the forgiveness of debt.
It’s an integrity provision designed to stop shareholders from getting an unfair tax advantage on what would otherwise be taxed to the shareholder as a dividend. Because of the broad definition of ‘associate’, Div 7a applies to relatives of shareholders and most discretionary trusts related to shareholders.
There are serious financial consequences if shareholders don’t do the right thing under Div7a. Where an amount does fall foul of the law, it will be treated as a deemed dividend of the shareholder or associate and a franking credit would not be applied to such dividend. Ouch!
How Division 7a Works
Imagine a private company with 2 shareholders - let’s call them Mum and Dad. They’re busy people, juggling family life and a successful business.
Occasionally they’ll use company funds to pay for personal expenses, usually on the company credit card. Other times the company will just pay invoices on their behalf. At month end their accountant bundles these expenses together and codes them to a shareholder loan in the company accounts.
The company also owns a beautiful beach house on the coast. Mum and dad spend their summers at the beach house, entertaining their nearest and dearest. The company has even purchased a jet-ski that keeps the kids entertained. That’s not so bad right? Mum and Dad aren’t tax cheats are they? After all, the company is theirs.
Unfortunately though, these are exact examples of what Division 7a targets. Mum and Dad may not have bad intentions, but they’re ultimately receiving a tax-free financial benefit from the company, either by way of funds or use of company assets.
But wait, there’s more. Another common example of where Div 7a might apply is where a trust distributes income to a private company (usually called a ‘bucket company’) and the funds representing that income is retained in the trust.
How to Stay on the Right Side of Division 7a
There are two ways in which falling foul of this tax law can be avoided. The easiest option is to repay the loan in full (or in the case of using company assets, make payment for use of that asset at market value). The slightly more complex option is to enter into a Division 7A loan agreement between the company and the shareholder or associate.
Where a Div 7a loan is entered into:
- The terms of that loan must be in writing
- Principal and interest repayments are required annually
- Interest on that loan must be at the minimum rate determined by the ATO annually
- The maximum term of that loan must not exceed 7 years (or 25 years where the loan is secured against property).
Key Dates and Division 7a Interest Rates
There are certain dates associated with Division 7a compliance that private companies should be aware of. These dates are non-negotiable and failure to comply may result in an unfranked deemed dividend for the shareholder (or their associate).
- Company’s lodgement due date: Action taken to avoid Division 7a must occur before the earlier of the company’s lodgement due date or actual lodgement.
- 30 June: Where a Division 7a loan agreement is entered into, minimum yearly repayments of principal and interest must be made by 30 June each year.
- The benchmark interest rate for the income year ended 30 June 2023 is 4.77%
Seek Advice from BlueRock’s Tax Advisors
Division 7a is complex so it's important to speak to a tax consultant who can advise you on the best course of action for your circumstances. At BlueRock, we have a team of experienced tax advisors who can guide you through the complex world of Division 7A and help you stay on top of your tax obligations. So, don't let tax laws become an expensive headache – give us a call today and let us take care of tax compliance and tax planning for you!
